The debate about India’s manufacturing usually focuses on what happens inside the factory: productivity, technology, capital, and skills. But a factory's scale is limited by the size and number of markets it can profitably serve. A firm may be capable of producing more, yet find that the cost of reaching new and more distant customers eats up any return to expansion.
The rise of digital commerce has provided new ways for firms and customers to find and transact with each other. But manufacturing still relies on the physical movement of goods. Products have to be stored, transported, and delivered, and the cost of doing so rises as firms reach farther beyond their immediate markets.
Indian governments invested extensively in transport infrastructure in the two decades following the economic reforms of 1991. This period offers a useful view of how the cost of reaching distant markets shaped Indian manufacturing, and what happened as connectivity improved and that cost began to fall.
Distribution Costs Increase Faster Than Sales as Firms Expand
Distance imposes more than one kind of cost on a manufacturer. Not only is shipping goods farther more expensive, but reaching a distant market can also require a firm to build a distribution network, find local partners and overcome information and contracting frictions.
The first of these costs can be measured directly. Indian manufacturing plants report what they spend on transport, packing, insurance and sales commissions in the Annual Survey of Industries. These expenses are large. Between 1993 and 2013, plants spent an average of 3.2 percent of sales on distribution, more than half the share accounted for by labour costs. Relative to value added, this figure was even higher at 10.2 percent.
Large plants spend relatively more on distributing their products than smaller plants. As a share of sales, distribution costs were more than three times higher among plants in the largest size decile than among those in the smallest. A natural explanation is that growing a plant means selling to more distant customers, so each additional rupee of sales costs more to distribute than the last.
Distribution Costs Are Amplified through the Supply Chain
The combined effect of these costs is much larger than a 3 percent share of sales might suggest. A simulation calibrated to the survey data captures how distribution costs affect firms' ability to sell their goods across space. A simple counterfactual illustrates their economy-wide significance: if plants could distribute their products for free, household consumption of manufactured goods would be over 20 percent higher. There are two reasons why a cost of a few percent of sales can matter so much.
First, distribution costs are not paid only once, when a finished product reaches a household. Manufacturers are each other's biggest customers: materials bought from other manufacturers account for around 60 percent of manufacturing sales. So when a plant ships its output, it often pays to deliver an input to another factory, whose price then has to cover that delivery cost, and which will in turn pay to ship its output onward. By the time a product reaches a household, the cost of moving goods has been built into its price several times over.
Second, the firms that bear the highest distribution costs are the large, productive ones that would otherwise expand furthest. High distribution costs therefore fall most heavily on precisely the firms with the greatest potential scale. Eliminating the extra cost of serving distant customers would raise consumption of manufactured goods by around 9 percent. Almost half of what distribution costs the economy comes not from the level of those costs but from how steeply they rise with distance.
Connectivity Expands the Geographic Reach of Manufacturing Firms
The 2000s show what happens when the cost of reaching distant markets falls. Between 2000 and 2010, distribution costs fell from 3.8 percent to 2.9 percent of sales, even after accounting for changes in the composition of manufacturing industries, and the decline was steepest for the largest plants. Over the same period, the share of manufacturing sales crossing state boundaries rose from 23 percent to 32 percent. Firms were reaching markets beyond their home states at the same time that distribution costs were falling.
Major transport investments were associated with this change, although the evidence is suggestive rather than conclusive. The Golden Quadrilateral, for instance, was associated with larger declines in distribution shares in states through which it passed than elsewhere.
A simulation calibrated to these changes suggests that consumption of manufactured goods was around 25 percent higher in 2010 than it would have been had distribution costs stayed at their 2000 levels. What is striking is where the gains came from. Cheaper shipping accounts for only part of them. The largest share comes from a fall in the cost of accessing distant markets in the first place: finding distributors, setting up sales networks, learning what customers far away want. Connectivity, in other words, is about more than the cost of moving goods. It is about how easy it is for a firm in one part of India to start selling in another.
Lower Distribution Costs Reshape Manufacturing Competition
The gains from lower distribution costs can emerge relatively quickly. In simulations of the adjustment, more than 62 percent of the eventual increase in household consumption of manufactured goods materialises in the first year because firms immediately benefit from lower costs in markets they already serve. Within a decade, between 80 and 94 percent of the gains have been realised, depending on how long we assume it takes firms to reach new markets.
But this adjustment is far from uniform. In simulations, the decrease in distribution costs from 2000 to 2010 led the bottom 25 percent of firms to exit, while 79 percent experienced a decline in profits. Larger and more productive firms expand as geographical constraints ease.
High distribution costs can therefore protect small local firms from more productive firms elsewhere. Lowering those costs does more than reduce an economy-wide expense: it changes the competitive landscape by allowing productive firms to enter markets that geography had previously insulated. That has a political economy implication: because most firms -- by number -- lose out, policies that raise aggregate output by improving market access may struggle to find a constituency, even when the overall gains are large.
Greater market integration therefore needs to be understood as a competitive adjustment with political implications, not simply a reduction in logistics costs.
What This Means for Policy
Distribution technologies may have changed since the period covered by this evidence, but the underlying constraint has not disappeared. Digital commerce may have lowered the informational cost of finding customers across India, but manufacturers still incur physical costs in serving them.
For India, manufacturing policy should therefore focus not only on making firms more productive, but on enabling productive firms to reach more customers and scale across markets. Roads, freight networks and logistics systems matter not simply because they lower the cost of moving goods, but because they help determine the size of the market a firm can profitably serve.
The objective of manufacturing infrastructure should not merely be to move goods more cheaply. It should be to make markets cheaper to reach.